Whenever it feels like a melt-up might be afoot, market participants (and the media) go looking for explanations and “culprits,” often landing on a familiar list of acronyms, from “TINA” to “FOMO.”
While it’s possible to put some numbers to “TINA” (and thanks to the backup in yields, there is an alternative now, by the way), you can’t really quantify retail “FOMO.” You can point to, say, record inflows into equity ETFs as evidence that retail investors might indeed be fearful of missing the next leg higher on the benchmarks, but you can’t cite any single metric and say “that’s ‘FOMO.'”
By contrast, it’s possible to identify signs that professional investors and traders are experiencing something akin to the psychological distress that grips Jane E*Trader on days when the Nasdaq closes up 2% and she didn’t buy that 0.3% “dip” in QQQ fifteen minutes into the cash session. For example, I often speak of “upside exposure grabs” and allude to evidence of interest in “right-tail.” You’ve heard folks like Nomura’s Charlie McElligott outline “crash-UP” scenarios.
Last month, for example, Charlie said he was “seeing signs that folks are emerging from the bunker and looking at broad market / SPX ‘crash-UP’ potential again” after spending a good portion of January and February focused more narrowly on upside in pro-cyclical and reflation expressions, with index upside relegated to “an afterthought at best.”
With this in mind, Macro Risk Advisors’ Dean Curnutt said this week that “there may be no greater risk for investors right now than underestimating just how powerful the trio of economic reopening, deficit spending and committed Fed policy are.” For asset managers, the equivalent of “FOMO” may be “ROMO,” Curnutt suggested. That is: “Risk Of Missing Out.”
Fortunately for anyone who fears they may be running that risk, it’s finally attractive to “rent” the index again, Curnutt said, in a note marking a significant shift in his stance on vol.
“After a long stretch, equity index option premiums have finally squared with the level of realized volatility,” he wrote. “With changes in the pricing of implied volatility at the equity index level, we now consider options a far fairer deal than at any time post-pandemic.”
Regular readers will recall that a variety of factors had conspired to keep forward vol “stuck,” if you will. Anyone who needs a refresher on the relevant “demand-over-supply” dynamics is encouraged to review the quick explainer found here.
Late in February, JPMorgan’s Marko Kolanovic described similar distortions to those outlined in the linked article, noting that the VIX had become increasingly disconnected from underlying short-term realized. “The spread between the VIX and two-week realized vol sits in the 99.6th percentile going back three decades,” he wrote, adding that “based on historical data of equities and the VIX, one should expect a decline in the VIX and rise in the S&P 500, consistent with our forecasts and price targets.”
In the same Monday note, MRA’s Curnutt wrote that the supply-demand dynamics mentioned above “not only left implied volatility at a high level relative to history but also at a hefty premium to realized vol.”
It’s been the same story for months, but the spell appears to be breaking. And not a moment too soon if you’re running the risk of missing out on any assumed further upside.
One factor helping to ease some of the tension in the vol complex is a reversal in apparent hedging interest via the VIX ETNs. For example, Curnutt noted that the disconnect between the VIX and realized in January and February was accompanied by product inflows, while March saw the dynamic reverse, as ETN assets fell and the disconnect narrowed. “While we are always cautious to ascribe cause and effect, it wouldn’t be a stretch to attribute periods of disconnect between then VIX and level of realized volatility to these inflows,” he said.
The bottom line, for Curnutt, is that the “trifecta” of fiscal stimulus, expectations of a grand re-opening (as vaccine rollout continues apace) and Jerome Powell’s seemingly ironclad pledge to remain accommodative in virtual perpetuity, means the risk of missing out is both palpable and real.
The good news, for fund managers, is that renting upside via options is no longer an unreasonably expensive proposition.
